Green Mountain Coffee Roasters (GMCR) is the Vermont Based K-Cup and [Keurig] brewer manufacturer that has been the darling of its home state and a cult of retail investors that have enjoyed the catapult of its stock price over the last few years--peaking at $115 before the collapse to $50 (and lower for a short time). Since this collapse has become very public recently--through the extraordinary 110 slide presentation by David Einhorn, Sam Antar's articulate white collar blog, CNBC's Herb Greenberg, and countless other media sources that covered both sides of the argument--I will try to limit our rationale behind our short positions on a few crucial bullets.
Despite the recent stock decline, GMCR still has a $8.15 Billion Market Cap, while their sales are projected to hit $4.3BB in fiscal 2012, and past "real" earnings power has been zero. The Bulls can say what they wish about GAAP vs. Non GAAP earnings, sustainable valuation is ultimately based off of how long it would take a buyer of the entire business to break even. When your business has negative cash flow, then the multiple used has to be based on other values the business carries, such as revenues, tangible assets, intangible assets and other metrics. A growing business that just generated $2.7 Billion in sales is definitely worth something, but no buyer in their right mind would ever say it's worth $8 Billion.
Everyone knows that GMCR's patents are expiring in September 2012, which is opening the door to new competition that GMCR has never faced before. What I think the street is missing at this point is that the competition is already here, and not waiting for September. Walmart (WMT) already announced that they will be offering a lower priced single-serve coffee brewer by ESIO Beverage to compete with GMCR later this year. Starbucks (SBUX), a banner customer of GMCR, may end up being a former customer eventually since they just announced that they are launching their own brewer later this year. Their brewer not only does coffee, but also espresso.
These are no ordinary competitors. This is the equivalent of COSTCO (COST) opening up right next door to a mom and pop supermarket; it's just unfair. Despite SBUX's Schultz being the perfect politician during the Verisimo conference call, the worst part of the new competition has not even been addressed by anyone--the Verisimo is not compatible with K-cups. Even though both companies "say that they're not competing," the reality is that since both brewers have different technology, the two will have to battle for each customer since they can't expect people to buy both machines. SBUX has over 17,000 stores as their distribution network, GMCR has Starbucks. It's no wonder they named the brewer after an opera style, someone always dies.
Accounting irregularities pointed out by both Einhorn and Antar, along with our research, show that the GMCR numbers literally don't add up. Aside from the fact that it appears the money is moving from the right to the left pocket when reviewing inventory and accounts receivables, the actual numbers simply don't add up. GMCR always looks like they are about to run out of cash, showing a balance of barely $13 Million last quarter before the increase to $84 million in the most recent quarter. Either amount does not seem sufficient to us if they're really planning on using it to run a $4 Billion revenue business. Maybe that lapsed CPA license their CFO, Frances Rathke, failed to disclose really does matter?
Insider Selling A Trendy Business
GMCR's executives and former major shareholder, Lavazza, have been selling the stock as if it is poisonous...never a good sign. By selling, I don't mean the small lots of a few hundred shares sold here and there which is common practice by employees of big companies trying to monetize their bonuses. I'm referring to the millions of dollars worth of stock being sold by the company's leaders on what seems like a weekly basis. These are the very same people bulls rely on to know the current and future state of the company better than anyone else. This trendy business has never seen a downturn, therefore the market is pricing it to perfection. If the insiders' actions say it's poisonous, then we have to agree.
Under the current business model, and assuming that everything is legitimate, we believe that the maximum value of the business is somewhere around 1x TTM Sales ($2.7BB) or approximately $17/share. If the accounting shenanigans prove to be true by the regulators rather than by management admitting a mistake, then the brand will likely be irreparably harmed; therefore the business is only worth its liquidation value of assets after paying debt, while the stock may end up disappearing. What the bulls don't understand is that the short bet does not depend on every one of these catalysts coming to effect. We only need one.
Eeni Mini Miny Mo, Which Catalyst Will Make Green Mountain Fall?
Disclosure: I am short GMCR. I am referring to our fund - RCI. RCI does not have any positions in WMT, SBUX, COST, and has a short position in GMCR.